New Delhi: Fitch Ratings on Friday said Indian authorities are making a more concerted push to clean up bad loans in the banking sector but the move would impinge on banks’ profitability in the short-term.

It said that asset resolution would be a dominant theme in the sector over the next few years and further losses may push some weaker banks closer to breaching minimum capital requirements, unless they receive pre-emptive capital injections.

“Recent regulatory actions in India suggest the authorities are making a more concerted push to tackle banks’ bad loan problems. “In the short-term, this is likely to create provisioning costs that will mean continued pressure on bank profits,” Fitch said.

Moreover, the clean-up exercise undertaken by the government may bring about consolidation in the banking space.

“We believe it has become more likely that the number of state banks will fall in the medium term,” it said. Banks are straddled with anywhere between Rs 9 trillion and Rs 12 trillion of stressed assets - made up of bad loans, restructured debt and advances to companies that cannot meet servicing obligations.

The government earlier this month through an ordinance amended law to give powers to the Reserve Bank of India (RBI) to order banks to initiate insolvency proceedings against defaulters and create committees to advise them on recovering NPAs.

The increased powers given to the RBI to clean up asset quality, and to intervene at an early stage when risks build, represents an “important positive step” toward ensuring a healthy banking system in the future, Fitch said.

“RBI direction that pushes banks into initiating insolvency processes against borrowers could help to break a deadlock caused by concerns among bank officials that decisions on troubled borrowers will attract investigation by anti-corruption agencies,” the US-based agency said.

It also said there is a “stronger intent and willingness” from the authorities to address the NPA problem. There will be significant implementation challenges, but asset resolution is likely to strengthen over the next few years.

“The resolution of non-performing loans is likely to require significant haircuts if the re-priced loans are to attract attention from private investors and asset- reconstruction companies,” it said.

State-run banks, which hold the bulk of stressed assets, are likely to report low returns on assets for the current fiscal.

“Further losses at some of the weakest small-to-medium sized state banks could pressure them to shrink, or to eventually exit the system by entering into forced mergers,” it said.

Fitch said the authorities should manage this in a way that is least disruptive for the financial system, but the process will entail risks for investors of capital securities, at least in the case of weakest banks.

Large state banks will also face higher provisioning costs, Fitch said adding these could eventually receive more capital from the government than has already been budgeted.